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Thursday, May 9, 2013

A Contrarian Perspective on Baseload Power

by Michael VickermanThough equipped
with a license to operate for an additional 20 years, the Kewaunee nuclear power
station rode into the sunset this week, having generated its final
kilowatt-hour. Dominion Resources, the Virginia-based company that owns the 550
MW facility along Lake Michigan, plans to spend nearly $1 billion to
decommission the facility and transform the acreage back to its former status
as farm fields. The process could take as long as 60 years.

It’s more
than a little odd to see a 39-year-old nuclear plant taken offline in a state
that’s replete with middle-aged fossil units. But in this story, age and fuel
type matter less than the extremely unfavorable market structure confronting an
independently owned baseload plant in the Upper Midwest, especially one lacking
a power purchase agreement.

Back in
2005, when the Kewaunee plant was sold to Dominion, the prevailing expectation
among Wisconsin electricity stakeholders was that sales and revenues would
never stop growing. They were convinced then that there would be room for every
new power station on the drawing boards or under construction. But when reality
intruded in the form of a nasty economic contraction, electricity loads headed
downward.

Just
after the peaking of electricity sales in 2007, an unusually large wave of new
generating units came online, including a mammoth 1,235 megawatt (MW)
coal-fired plant just south of Milwaukee. (More about the Elm Road station
later.) In a flash, the once roomy environment for power plants vanished,
leaving in its wake a glutted field of generators trying to stay afloat in a
shrinking pool of revenues.

Wholesale
electricity prices in the Upper Midwest are set in accordance with a
generator’s marginal cost of energy. Without a captive rate base to underwrite
safety upgrades and relicensing expenses, Dominion desperately needed a power
purchase agreement to have any chance to operate Kewaunee at a profit.

But the
utilities, who have their own middle-aged generators plants to protect, were
not about to throw a lifeline to Kewaunee. Recognizing an opportunity to thin
the generation herd without having to write down one of their own assets, they
decided to let brute economics administer the coup de grace to an unwanted
competitor.

As a
baseload plant, Kewaunee was poorly adapted to compete in a depressed market.
Nuclear power plants operate pretty much at one speed--full throttle—and end up
producing the same quantity of electricity at 2:00 AM, when the wholesale price
of electricity in the Upper Midwest is often below the cost of production, as
they do at 2:00 PM, when the prevailing price is at or above production cost.

Unfortunately
for a generator like Kewaunee, there are more off-peak hours than on-peak hours
in a year. When baseload plants compete in a market that does not cover the
marginal cost of operations, they tend to hemorrhage money.

Ten years
ago, baseload generators were touted as the firewall that would protect
ratepayers against price gouging orchestrated by unscrupulous power marketers
like Enron. Today, we have a diametrically opposed dynamic. In a chronically
depressed market, baseload generators are the ones in greatest need of
additional ratepayer outlays to sustain them.

This
point merits much more discussion than can be squeezed into this column, as it
signals the emerging obsolescence of the traditional utility business model.
Suffice it to say that we can now appreciate baseload generation as a luxury
made affordable by rapid load growth rates that allow the investment in
capacity expansion to be spread over a larger population of ratepayers. Sustained load growth encouraged utilities to
capture economies of scale by building centralized power plants and running
them flat out over many decades. This growth was essential for driving power
prices lower through much of the previous century.

But when
loads stop growing, the operational inflexibility of a large coal or nuclear
plant becomes a liability. Unlike a gas-fired turbine, a baseload coal plant
cannot be ramped up and down without incurring wear and tear. And, unlike a
solar electric array, a baseload generator cannot turn itself off at night,
when wholesale energy prices fall through the floor.

Nowhere
is this situation more evident than with Elm Road, the aforementioned coal
plant owned mostly by Milwaukee-based We Energies. With a price tag of $2.3 billion, this twin-unit
leviathan was the most expensive construction project in Wisconsin’s history.

And how
has it performed to date? In 2012 , its first full year of operation, Elm Road
produced only 18% of its rated capacity, roughly one quarter of its projected
output for that period. By comparison, We Energies’ newest wind power
installation, Glacier Hills, logged a capacity factor of 27% in 2012.

In March
2013, the most recent month in which utilities have reported their production
data, Elm Road’s capacity factor dropped to an abysmal 8%, the lowest
percentage among We Energies’ mainstay generators. Indeed, a hypothetical 1,235
MW solar farm in We Energies territory would likely have outproduced Elm Road
that month, recurring spells of cloudy weather notwithstanding.

Now, if a
new building was unable to achieve a 20% occupancy factor in its first year,
the building owner would face a stark choice: find more tenants or let the
banks take over. Similarly, if an airline found itself struggling to fill more
than one of every five seats in a given route, it wouldn’t take long for management
to cut back on the number of flights or cancel service between those airports altogether.

Unlike
the hypothetical airline or building owner, the parent companies that own Elm
Road are sitting pretty, because they can count on receiving monthly lease
payments that will, over a 30-year period, recover the capital sunk into that
plant, along with a tidy double-digit return on investment. Those lease
payments are now embedded in utility rates, whether Elm Road is cranking out
the kilowatt-hours or gathering dust.

The same
market conditions—low natural gas prices and depressed demand--that hastened
Kewanee’s retirement are partially responsible for Elm Road’s breathtakingly
poor performance to date. But the plant’s difficulties are exacerbated by its massive
size and its operational inflexibility.

There are
likely a few hours in every weekday when market prices rise high enough to
bring an Elm Road unit online. The trouble is, Elm Road is not equipped to
cycle like a gas-fired plant just to cover a few afternoon hours. When those
situations arise, the system operator dispatches a smaller, more flexible
generator that can do the job, even if Elm Road’s unit energy cost is nominally
lower. So Elm Road just sits there, consuming electricity instead of producing
it.

There is
simply not enough market space right now in Wisconsin to accommodate a large
newcomer like Elm Road at anywhere near its rated capacity, even after
Kewaunee’s departure. Until the generation herd thins out some more, Elm Road’s
utility to the ratepayers who are picking up the tab for this monumental
misallocation of investment capital will remain virtually nonexistent.

The
lessons from Kewaunee and Elm Road are clear: building baseload plants belongs
to a bygone era. The older ones are fraught with legacy costs, while the newer
ones carry burdensome financial risks. Those states that manage to avoid the
choking levels of overcapacity we have in Wisconsin have plenty of room to
stake out an aggressive clean energy development program going forward.